The two main tax equity structures are sale/leasebacks and partnership/flips. The ITC is a one-time credit against income tax that is based on the amount invested in a facility. The ITC is subject to recapture if, within five years after a facility is “placed in service,” the taxpayer sells or otherwise disposes of the project or stops using it in a manner that qualifies for the credit – like taking it out of service or permitting the PPA off taker to operate and maintain the project.

Sale/lease back

A sale/leaseback is a sale to a tax investor of solar equipment and an instant lease back to the developer of the same equipment so the developer can use it (typically to sell the generated power to a third-party host). It is attractive to developers because it offers 100% upfront financing and a “step-up” in ITC basis upon the sale for fair market value, although the IRS rules require there to be a 20% residual value at the end of the lease term, making the end-of-term purchase price higher than that seen in a partnership/flip. Documentation usually involves a Purchase Agreement and Bill of Sale (for the sale part) and a Lease Agreement and Rental Schedule (for the lease part). Investors (Lessors) will take assignment of the deal collateral (mainly project documents) under a security agreement (or, for real property, a mortgage or deed of trust). Third party consents are required for each project document, even when the document is expressly assignable, as the consents provide the investor with estoppel language and additional rights and remedies.

Sale/leasebacks have three end-of-term options:

  1. A purchase option for fair market value.
  2. A renewal option (not to go beyond 80% of the equipment’s useful life)
  3. A return option. The return option must be a viable option and the sale/leaseback documentation cannot be read to compel the Lessee to exercise the purchase option. It is therefore imperative that the PPA and Site Document counterpart(ies) agree that the investor (or Lessor) may take direct assignment of such project documents at the end of the sale/leaseback term in order to preserve the option for the developer (or Lessee) to return the solar equipment in place – this agreement is typically contained in the third party consents, but is even better placed in the project documents from day one.

The sale/leaseback closing typically takes place after Substantial Completion of the project (due to a 90- day window permitted by the IRS to enter into a sale/leaseback transaction after the placed in service date and still be eligible to take the ITC) and the EPC Contract will accordingly be mostly performed – consequently, review of an EPC Contract for these transactions focuses only on warranties, indemnities, performance guarantees, and any other provision that would survive full performance or give rise to a claim (such as a guaranteed substantial completion date and subsequent LDs). As the investor is the project owner and the developer is the project company owner, it is important to note who is the beneficiary of the warranties and whether they are assignable. Further, since there is a sale of equipment taking place, it is important for the client to note whether a sales tax exemption is available in the relevant state under a “sale for resale” or other exemption for the initial sale, and what taxes are imposed on the ongoing rent payments. In sale/leaseback transactions, the developer usually takes risks relating to timing of placement in service, ITC amount, and ITC timing, and the investor usually takes risks relating to structure/true lease risk, rent accrual patterns, and residual risk (change in law risk is negotiable).

 Partnership/flip

A partnership/flip is a simple concept - a developer brings in a tax investor as a partner to own a solar/storge project together. In a yield- based flip, the partnership allocates taxable income and loss ~99% to the investor until the investor reaches a target yield, after which its share of income and loss distributions flips to a lower percentage and the developer has an option to buy the investor’s interest. Cash is distributed in specified ratios before the flip based on expected energy production and timing of the flip date. In addition to the yield-based flip, there is also a fixed-flip structure that is used principally by US Bank and leaves as much cash as possible to the developer – in these, there is usually a cash flip at the 5th year and a tax flip at the 6-7th year, with a 2% preference to the investor and some sharing on additional distributions if production is good. Flip deals are different than sale/leasebacks in terms of the amount of capital raised, risk allocation and the timing of when the investor must invest. A sale/leaseback provides the developer with the full fair market value of the project (in theory). In a partnership/flip, the investor contribution is usually 40% to 85% of the fair market value and the developer must provide the rest.

For the investor to be eligible for the ITC, it must be a partner in the partnership prior to the assets being placed in service – for this reason, investors typically contribute 20% of their investment related to a project after mechanical completion of such project, but before it is placed in service. The remaining 80% is typically contributed after substantial completion of the project is achieved. For this reason, financing parties review an EPC Contract for a partnership/flip transaction with more emphasis on the requirements for mechanical completion, as well as the remaining obligations of the EPC contractor after mechanical completion is achieved. Unlike in a sale/leaseback, the investor is taking some construction risk – for the period between mechanical and substantial completion – and will care about contractor obligations and remedies from and after the mechanical completion date. Also, unlike a sale/leaseback transaction, the investor is an owner in the project company and will not be taking a security interest in the project documents – therefore only an estoppel certificate will be required from the third parties (and no third-party consents to assignment).